Bair talks of battle over bank bailout rules

Ex-regulator raises concerns about stress tests

By

RonaldD. Orol

WASHINGTON (MarketWatch) — The process of setting up rules to dismantle a big failing bank so it doesn’t cause a Lehman-like seizing up of the financial system was a battle pitting one regulator against another, the former chief of the Federal Deposit Insurance Corp. said.

Sheila Bair, who ran the FDIC between 2006 and 2011 during one of the most tumultuous periods in U.S. financial history, spoke with MarketWatch after publishing a new book, “Bull by the Horns.” She talked about her disputes with Treasury Secretary Timothy Geithner over the new system and her concerns over the Federal Reserve’s stress tests of big banks.

Specifically, she backed a new system set up under her oversight know as an “orderly liquidation authority,” that allows the FDIC to use taxpayer dollars to make payments to creditors and counterparties of a failing megabank so they don’t fail as well, unsettling the markets further. (Those taxpayer dollars are later recouped in fees on big banks).

With this authority, regulators hope that they won’t need to prop up failing institutions in the future using taxpayer dollars, as they did with American International Group Inc.at the height of the crisis, or let them fail in a disruptive, Lehman Brothers–like manner.

Critics of the measure insist that there is still the perception that big banks could receive “backdoor” bailouts through the liquidation authority by providing taxpayer funds to big banks that are bondholders of the failing institution.

Reuters

Daniel Tarullo, Governor on the Board of Governors of the Federal Reserve System, Sheila Bair, then-chairman of the Federal Deposit Insurance Corporation, Mary Schapiro, Chairman of the Securities and Exchange Commission and Gary Gensler, Chairman of the Commodity Futures Trading Commission are pictured during a House Financial Services Committee hearing on financial regulatory reform on Capitol Hill in Washington, June 16, 2011.

However, Bair said that the system seeks to use taxpayer funds only to keep the firm operational by making payments to critical employees, technology providers and security and maintenance personal that are necessary to keep the firm functioning while regulators and management figure out what losses other creditors such as long-term bondholders including other banks would need to take.

“Before I left I proposed and finalized rules to make sure that long-term bondholders would never receive additional payments and that they are subject to loss just like the equity shareholders and some debt holders are,” Bair said. “This is a very good new process that will protect taxpayers from bailouts going forward. Dodd-Frank explicitly prohibits bailouts.”

Bair said she had a disagreement with Geithner over the rules. She said that Geithner was concerned about limits on the government’s discretion to bailout bondholders. Some critics of the system worry that an inability to bail out bondholders could discourage investors from buying long-term debt.

However, she said the FDIC was supported in its tough rules on this class of creditors by the Fed and that Geithner eventually acquiesced. An official in the Treasury Department did not return a request for comment.

She also argued that regulators now require big banks to submit so-called “credit exposure reports.” These reports require large institutions to identify their inter-relationships periodically. This process should help limit collateral impact of one bank failure on others, Bair said.

“If banks hold a lot of their debt, or if they hold of a lot of another bank’s debt they need to identify that to regulators now and the regulators obligation is to reduce those exposures, so if they go down they do not impose material losses on other financial institutions,” Bair said. “So you don’t get into situation where one big bank goes down and five others suffer material loss.”

Bair, a Republican who is now a senior adviser at the Pew Charitable Trusts, also said stress tests rules approved Tuesday set to be conducted on a broad group of over 100 institutions are a “net positive” because it has examiners taking a more forward-looking view on what’s on a bank’s balance sheet and pressing the bank’s management to do the same. Read about how the U.S. approves stress tests for 100 banks

However, she added that the stress tests can be improved, noting that in the past the Fed has looked at a bank’s risk-based capital levels and that wasn’t good enough.

Bair said the market has more confidence in a leverage ratio that focuses more on a bank’s common equity.

“We found during the crisis that the market doesn’t believe a risk-based capital level which can be heavily influenced by banks about how risky they think their assets are,” she said.

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